Did you know that companies under private equity (PE) ownership are statistically at a much higher risk of going bankrupt? In fact, PE portfolio companies are about ten times more likely to declare bankruptcy compared to their non-PE counterparts. While one in five bankruptcies doesn’t necessarily mean failure is destined, the starkness of this statistic certainly raises eyebrows. It’s essential to recognize that PE firms often target companies in distress, contributing to this troubling trend.
However, this shouldn’t eclipse the broader implications of the practices employed by these firms.
The Real Impact of Private Equity
In my experience at Deutsche Bank, I saw firsthand how financial structures can be transformative, yet often disruptive. Brendan Ballou, a former federal prosecutor and author of Plunder: Private Equity’s Plan to Pillage America, recently underscored the need to scrutinize the recurring actions that disproportionately benefit PE operators while harming the broader economy. During a discussion hosted by CFA Society Hong Kong, Ballou shared valuable insights on how PE firms leverage their influence, often leading to outcomes that are detrimental for companies, employees, and the economy as a whole.
One major topic we discussed was the mechanics of leveraged buyouts (LBOs). Typically, PE firms invest minimal equity from their own funds, instead relying heavily on borrowed money and investor capital to acquire target companies. The aim? To turn a profit in a short span of time. But this myopic approach can have severe consequences for the companies they acquire.
Ballou pointed out a striking reality: despite the significant workforce these firms employ through their portfolio companies, public awareness of their operational practices is alarmingly low. The fallout from PE ownership can include higher bankruptcy rates, substantial job losses, and negative impacts on crucial sectors like retail and healthcare. The issues stem from three main factors: the short-term focus of PE firms, their reliance on excessive debt, and their ability to avoid legal accountability.
Case Studies: The Dark Side of Private Equity
To shed light on the negative consequences of PE ownership, Ballou shared two compelling case studies. The first involved a sale-leaseback arrangement orchestrated by a PE firm with a regional retailer, effectively stripping the company of valuable real estate assets during a critical growth period. The second example revolved around dividend recapitalizations, where portfolio companies borrow funds solely to pay dividends to the PE firms, often leaving them laden with unsustainable debt.
These practices prompt a crucial question: are traditional business strategies being misapplied in a way that prioritizes short-term gains over long-term viability? While strategies like sale-leasebacks aren’t inherently problematic, their execution within a PE context often results in a “heads I win, tails you lose” scenario, creating significant pain for stakeholders beyond the sponsors themselves.
Furthermore, legal frameworks and a lack of accountability only complicate the situation. PE firms often maintain operational control without facing the financial or legal repercussions of their actions, allowing them to reap benefits in favorable conditions while sidestepping consequences during downturns.
Regulatory Implications and What Lies Ahead
The current landscape raises urgent questions about the sustainability of private equity practices. As Ballou highlighted, the call for regulatory changes is critical to align the actions of PE sponsors with the long-term health of businesses and their communities. The CFA Institute Research and Policy Center advocates for transparent markets and robust investor protections, emphasizing the need for reform in light of PE’s increasing influence.
While private equity has undeniably reshaped the economy and continues to gain traction, it’s vital to create a regulatory environment that promotes long-term responsibility. This might involve states imposing conditions on PE firms to ensure accountability, especially in cases of job losses or harmful financial repercussions stemming from extractive practices.
In conclusion, professionals across various industries must recognize the potential dangers associated with private equity and champion practices that encourage sustainable growth. The future of private equity will hinge on a collective effort to foster a long-term perspective among investors and firms, ensuring that this sector contributes positively to the economy rather than exacerbating inequalities.
